Thursday, October 2, 2008

Here's today's squeak from the wheel. We've been letting up on the poor Wall Street Journal for the past week or so. Their articles are sounding more and more the same as they continue to promote the new capitalist-socialism (or was it the old socialist-capitalism?) as the alleged solution to the bailout of their fellow gamblers and speculators. Since no one likes to feel ignored, we sent this today, just in case they're feeling lonely.

Dear Sir(s):

The headline in today's Wall Street Journal announced that the Federal Reserve was contemplating lowering "the interest rate" (meaning the Federal Funds Rate) in order to stave off the danger of a "recession." ("Fed Considers Rate Cut As Recession Fears Mount," WSJ, 10/02/08, A1) Evidently you still fear to use the "D-word," even in light of conditions that are starting to make 1929 look like a penny stakes poker game.

A conundrum with which we've struggled for many years is how, in the interest of protecting the free market, the Federal Reserve (the central bank of the United States) justifies controlling the price of the single most important input to the productive process in an organized economy: money and credit. "Money and credit" being simply terms for quantified promises to convey value, what the Federal Reserve does is put a price on the ability to make promises that has no relation to the cost of administering a regulated system of promises.

Added to this is the fixed belief of many people — even bankers and economists — that capital can only be formed (i.e., investments made and businesses run) out of existing accumulations of savings. If there is no money in the system to lend, they believe, then business will be "starved" for credit, and the economy will grind to a halt.

This is not the case at all. The Federal Reserve has the power to create money at will through the extension of credit. This power is exercised almost every day to finance government spending. This is contrary to the spirit of the Federal Reserve Act of 1913, which prohibited the Federal Reserve from dealing in primary government securities, and only allowed dealing in secondary government securities in order to affect reserve requirements of commercial banks.

Section 13 allows the Federal Reserve to create money by extending credit through commercial banks by discounting qualified industrial, commercial, and agricultural projects. If the Federal Reserve extended credit and thereby created money only in response to sound, financially feasible investments, there would always be sufficient money and credit in the system to keep the economy running, and the currency would be backed 100% by hard assets — no need to maintain fractional reserves. If, further, the credit was extended and money created in ways that made more people into owners of capital, then the economy would (absent natural disasters and other external disruptions) always be in equilibrium; the shadow of recession and depression would be lifted.

Finally, since the Federal Reserve can extend credit and create money "out of nothing" (actually out of the productivity inherent in an economy and the ability of people to make and keep promises), the cost should be only what it takes to administer the system and enforce regulations. The term "interest rate" comes from "ownership interest," and represents the share of profits due to people who lend out of their savings. If credit is extended and money created in a way that does not involve existing accumulations of savings, there is no "ownership interest" to consider. The price of borrowing can be set at the administrative cost.